China woes hit tech firms but experts dismiss bubble fears

Some of the world’s biggest technology companies have taken a pummelling at the hands of wary investors in recent weeks. In the month to 27 August, the likes of Google, Yahoo, Facebook, Twitter, Netflix and LinkedIn suffered double-digit falls in their share prices.

But is the recent decline in the popularity of tech stocks simply a reaction to growing uncertainty about the Chinese economy, or is the sector facing more fundamental problems?

What’s behind the fall?

On Monday last week, the Chinese stock market fell 8.49 per cent to close at 3,209.91. The fall caused a ripple effect across Europe, with the FTSE 100 dropping 2.4 per cent on the back of the sell-off.

Tech stocks in particular took a beating, with the price of a host of companies plunging in the wake of global uncertainty.

Axa Wealth head of investing Adrian Lowcock says tech companies are more susceptible to global market corrections due to the nature of their earnings models.

He says: “Many tech stocks are highly valued in anticipation of future earnings and are therefore susceptible in a sell-off. They were already expensive and are riskier, less defensive companies.

“We saw a big correction amid concerns over the strength of the Chinese economy and the outlook for global growth. If the world enters recession, then you want to be in companies that are able to deliver consistent and reliable earnings.”

Dotcom bubble

While tech stocks have clearly suffered in recent times, experts are quick to dismiss any comparison with the dotcom crisis at the turn of the century.

During that period from peak to trough, the Nasdaq Composite index – which is heavily weighted towards tech firms – lost 78 per cent of its value, falling from 5,046.86 to 1,114.11.

Putting aside recent volatility in the market, the Nasdaq 100 has remained roughly stable throughout the year, pulled north by the likes of Google and Facebook but dragged down by companies, including Microsoft and Apple.

But over five years, the index has surged from 1,825.75 in August 2010 to a high of 4,661.60 in July. The recent rout saw the index drop back to 4,117.67 as of 25 August.

Hargreaves Lansdown senior analyst Laith Khalaf says although the sector’s current woes mean it is not a buying opportunity for investors, comparing recent valuation drops to the 2000 onslaught would be wide of the mark.

He says: “Overall, the tech sector valuation looks largely in line with its historical average, which suggests it is not a screaming buy but neither is it in bubble territory.

“The price/earnings ratio is currently just under 20 times, compared with over 70 times earnings during the tech boom of the late 90s and a long-term average of 24.

“Firms such as Apple, Google and Microsoft, with their huge global revenue schemes, are barely comparable to some of the blue-sky concepts that passed as tech companies during the dotcom bubble, and these stocks clearly dominate the technology sector because of their size.”

Axa Framlington Global Technology fund manager Jeremy Gleeson says valuations are “nowhere near” the levels seen in 2000. “Valuations are very much in line at the moment. If you want to find a bubble, there is always an area within the equity market that is attracting disproportionate amounts of cash. But there is no bubble in the tech sector.

“The price index may have increased, but the valuation has not. If technology was in a bubble, you would expect valuation metrics for the tech components to be at a significant premium to that of the broader equity indices, which isn’t the case.”

Stock selection

While investors may be cautious about exposing themselves to a sector that is being swept up in the current global economic whirlwind, fund managers argue there are buying opportunities in certain market segments.

Companies producing semi-conductors – the compound at the heart of microprocessor chips – present one such opportunity, says Gleeson.

He argues: “In the first half of this year, we have been reducing our exposure to semi-conductors. We benefited from a number of take-overs in the space, and some of the stocks we held were at the high end of their range, so we took profits out of that market.

“We had been overweight in that sector for a number of years, but a lot of those companies have been impacted significantly during the sell-off in the past few weeks. We may look to reinvest in that market again because, fundamentally, nothing has broken down.”

Henderson Far East Income fund manager Michael Kerley, who has an 11 per cent weighting towards the technology sector, is also positive on semi-conductor producing firms but warns companies reliant on traditional PC sales are likely to struggle.

He says: “We know companies aren’t investing, and that has hurt the replacement cycle for PCs in the corporate sector.

“We have Microsoft 10 coming next year, and if that is successful we may see an upgrading cycle in corporate spending. But on the retail side it is tough because we have cannibalisation between tablets, smartphones and notebooks. The overall demand for these products as a whole just isn’t growing.

“The reality is there is no killer product at the moment, and it is difficult to see where we go from here.”

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